Fundamental Properties of Linear Factor Models

Damir Filipovic and Paul Schneider

Papers from arXiv.org

Abstract: We characterize the loading matrices that admit a conditional linear factor representation for excess returns in which the factors are traded, residual risk is unpriced, and the loadings are the betas of the factors. The characterization is a joint restriction on the loadings, the risk premia, and the second moment matrix of returns. It requires no rank assumptions, and exactly one traded factor representation attains it for given loadings: the moment-weighted factor portfolios. On Fama--French panels, characteristic loadings differ from the regression loadings of their factors by 19 to 48 percent of their size, at every estimation window.

Date: 2024-09, Revised 2026-09
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